Analysis of current economic conditions and policy

The country’s gross domestic product fell 0.3 percent in the fourth quarter, the Office for National Statistics said on Friday, sharper than a 0.1 percent decline forecast by analysts.

The news is a blow for Britain’s Conservative-led government, which a day earlier defended its austerity program against criticism from the International Monetary Fund. It needs solid growth to meet its budget targets, keep a triple-A debt rating and bolster its chances of winning a 2015 election.

…

Osborne’s coalition partner, Liberal Democrat leader Nick Clegg, has said the government of which he is part had cut investment spending too rapidly.

It’s not as if observers hadn’t warned about the effect of contractionary fiscal policy. From the July 2012 IMF Article IV:

69. Deeper budget-neutral reallocations could also support recovery. Such reallocations within the current overall fiscal stance could include greater investment spending funded by property tax reform or spending cuts on items with low multipliers. Automatic stabilizers should continue to operate freely. It will also be important to shield the poorest from the impact of consolidation.

70. Scaling back fiscal tightening plans should be the main policy lever if growth does not build momentum by early-2013 even after further monetary stimulus and strong credit easing measures. To preserve credibility, any adjustment to the path of consolidation should be in the context of a multi-year plan and ideally accompanied by deeper entitlement reform, such as legislating accelerated increases in the pension age. Temporary easing measures in such a scenario should focus on infrastructure spending and targeted tax cuts, as they may be more credibly temporary.

What are the lessons from the UK experience? I think one can be learned from comparing the US to the UK.

Figure 1: Log real US GDP (blue) and real UK GDP (red), both normalized to 2008Q01. US 2012Q4 observation based on WSJ January 2013 survey. Source: BEA and UK Office of National Statistics, preliminary estimate.

Note the divergence in the two trajectories, post-(UK)election.

Now, it’s true that fiscal policy is only part of the overall macro policy framework. Monetary policy is also different between the US and the UK. Here is rely upon former MPC member Adam Posen’s assessment, as related by Adam Davidson in the NYTimes Magazine:

Soon after Cameron was elected, Posen argued that the committee should endorse a more radical, expansionary approach of economic recovery. He believed that the data indicated the sputtering would end and the economy would grow only if the Bank of England began buying many billions of pounds’ more worth of bonds. This added stimulus would flood the banking system with new cash and indirectly push banks to lend to businesses and citizens. (Banks don’t make money by sitting on cash.) Some of Posen’s colleagues warned that this would lead to inflation. He countered that the economy was operating below its capacity, so there was no reason to fear inflation.

Each month, the committee heard Posen’s advice. Each month, it voted 8 to 1 against him. The bank eschewed his more expansionary suggestions and stuck to a more conservative approach of keeping interest rates low and modest bond-buying. Soon Posen became a famously divisive figure in London’s financial community, alternatively the enlightened genius trying to save the country and the mad Yank who wanted to inflate the pound out of existence. “There was this period,” he remembers, “when I would lie awake at night and think: Am I just crazy? Maybe I’m nuts. It’s like the scene in ‘12 Angry Men.’ I almost wavered. But then I decided: No, no, no. I was convinced: They’re nuts and I’m right.”

It wasn’t necessarily that simple. Over the past several years, the economic data in Britain have been so unusual that they have forced a rethinking of some of the most fundamental assumptions underlying economics. There just isn’t any pre-existing narrative to explain what’s going on. When major market economies have experienced extended periods with little or no growth, like the global economy during the Great Depression or Japan in the 1990s, unemployment always shot up. In sluggish post-crisis Britain, though, unemployment has barely moved for three years.

Davidson is not quite correct to state the results in the UK were to strange — as Paul Krugman has repeatedly observed, slow growth was to be expected. In other words, I think that the evidence has now accumulated to totally overwhelming levels that Posen, and the others who believed that a front-loaded fiscal contraction combined with less than fully expansionary monetary policy, were correct in their assessment of the UK situation. And the fact that the US has grown substantially faster with a more expansionary fiscal and monetary policy framework in place is consistent with the view that growth cannot be induced by contractionary fiscal and monetary policies in the current economic environment.

You are giving our fiscal policy makers to much credit, they aren’t done yet. It sounds like Obama wants to layer on some more taxes and fees that will effect everyone. New gas tax, carbon dioxide tax, etc. I doubt he will get it through congress, so the czars will do it through fees, fines, etc. Ultimately, the consumer will pick up most of the tab, so it will be regressive.
On a related note, the UK is using the EU’s carbon dioxide policies as a reason to reconsider it’s relationship with the EU.
On another related note, the Center for International Climate and Environmental Research-Oslo, has a new study that suggests climate sensitivity to carbon dioxide is only 1.9 degrees per century (range 1.2 – 2.9), much lower than the 3 – 4.5 catosrophic scenarios. It turns out most of the reduction comes from adding data from 2000-2010. Amazing that such a small window can have such a large effect. Every year that CO2 goes up and temperature anomaly does not will reduce the sensitivity by another .1 degree.
The study also finds the sensitivity to sulphate particulates is also lower than expected, so the cooling effect of sulphur particulates does not explain the earlier result.

Triple dip recessions separate the men from the boys.
“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate. It will purge the rottenness out of the system.”
A. Mellon to H. Hoover

To be clear and fair, spending in the UK has changed composition rather than shrunk. Spending on social maintenance has gone up but investment spending has tanked. And of course I mean government investment spending, not private.
An interesting piece of this, btw, is then that removing government investment spending hurts. As we hear all the time, that can’t be because that money is displacing private investment. This says that’s not true.

http://research.stlouisfed.org/fredgraph.png?g=eSg
The global economy is now so totally integrated and dominated by the largest 25-300 supranational firms selling to their subsidiaries and to one another that domestic nation-state monetary and fiscal policies have little influence on investment, trade, and capital flows among the three major trading blocs.
We truly have a global corporate-state trade regime in which the vast majority of the planet’s population have no financial wealth and thus no ownership of the means of production and increasingly not even their labor product for subsistence.
The long-term trend is “austerity” and decelerating real GDP per capita for the bottom 90-99% and an ongoing concentration of wealth, income, and political power to the top 0.1-1% on the way towards parity of fiat digital debt-money currencies, real GDP per capita, and trade and capital flows.
Tweaking monetary and fiscal policies at the margins is irrelevant with wealth, income, and power concentrated to such extremes to the top 0.1-1% around the world and accelerating automation of labor and loss of income and purchasing power of the bottom 90%.
Doubling down on growth of public debt and ramping deficit spending to prevent nominal GDP from collapsing is a symptom of a slow-motion depression, not a solution to its causes and effects, i.e., extreme wealth and income concentration, hoarding of financial capital/savings by the top 0.1-1%, financial speculation discouraging productive investment at labor returns, plunging money velocity, ongoing decline in wages/GDP, etc.
A radical redesign of the division of labor, money, work, income vs. wages, income distribution, and purpose, function, and funding of gov’t is desperately required to avoid a zombie apocalypse and our becoming “fish, plankton, sea greens, and protein from the sea” (the silver ice robot in “Logan’s Run”) to feed one another.

TJ. It’s funny that you would even include the phrase “On another related note” in your rambling post because nothing you said, in any remote way, is related to this post. I’m just dumbfounded how you can drudge up completely unrelated topics and pretend that you have something relevant to say about the article.

The case of the UK is very peculiar because the UK over the past 25 years has had extreme bubble conditions.
Because it has been been an oil exporter between 1982 and 2007, it has suffered from the “Dutch disease”, with an overly strong pound, and strong incentives to rent over production.
Because of the goal to shift politics to the right by making most voters petty rentiers, the housing bubble has been far more extreme than that in the USA, and the bust has been very moderate so far; and the housing bubble has been fueled by exporting debt.
Unfortunately now the UK is a net oil importer, with a weak currency, and the very partial housing bust has already caused the nationalization of the losses of most large UK banks.
The UK government is thus desperate to keep nominal interest rates as low as possible, for three reasons:
* If nominal interest rates rise, house prices will collapse, most mortgages will become unrepayable, and this will cause the collapse of all UK banks, something that nearly happened in 2008.
* If nominal interest rates rise, interest payments on the enormous private debt will balloon, and similarly for the fairly large public debt.
* If nominal interest rates rise, the pound will strengthen, causing exports to be even more difficult.
In order to keep nominal interest rates low the UK government has chosen many years of recession as their strategy, because recession keeps down imports of oil and allows nominal interest rates to be low without triggering higher inflation, which is already running fairly high because of the higher cost of imports.
If nominal interest rates go up, and the housing market debubbles causing the collapse of the UK financial systems, the UK will be in an situation similar to Ireland or Lithuania, with a very sharp, long depression, instead of a milder, longer recession.
The only difference between the two political sides in the UK is who is going to pay for this longer recession: conservatives think that the lower paid working classes whether employed or unemployed should pay for it in the form of much lower real wages, to protect the capital gains of rentiers; progressives think that the capital gains of rentiers should be protected too, but the higher paid employees and entrepreneurs should bear more of the cost of the recession than low paid or unemployed workers.
A very Japanese style solution is probably the most likely, and largely for the same reasons.

tj Well, London is only 79 feet above sea level, so if they want to give up on the EU’s carbon policies then the UK might want to think about a massive public works program moving the center of government to the Scottish Highlands.

“Over the past several years, the economic data in Britain have been so unusual that they have forced a rethinking of some of the most fundamental assumptions underlying economics.”
There are some unusual things happening. The article makes a comparison to the US in figure 1. Another comparison is found at this link…http://inequality.org/corporate-tax-avoidance-britain-americas-lead/
“Profits are rising even though the economy is doing badly.” – article quote
In spite of poor performances in the economies, US and UK, corporate profits are hitting highs.
My explanation compares the whole economy to a monopolist. First we look at the simple dead-weight loss to society from a monopolist.http://apecon2.wikispaces.com/Consumer+%26+Producer+Surplus+in+a+Monopoly
Then look at graphs #19 and #20 in my work.https://docs.google.com/file/d/0BzqyF_-6xLVEWUdJb2wxamJibW8/edit
Graph #19 shows a dead-weight in the whole economy similar to a monopolist. In graph #20, the separation of the pink and blue lines denotes the developing dead-weight loss since 2000.
Profits will rise as factor utilization decreases.
In short, it may be that we have so many institutions favoring companies to act with the power of monopolies that the whole economy now acts like a monopoly, instead of one of free market competition.

“In short, it may be that we have so many institutions favoring companies to act with the power of monopolies that the whole economy now acts like a monopoly, instead of one of free market competition.”
Edward, you are correct.
Consider that the revenues of the Fortune 25-300 firms are equivalent to 40-100% of US private GDP, even though they hire fewer than 13% of the entire US workforce. Most of US “exports” are in the form of capital goods, components, and ag products to US firms’ subsidiaries abroad or to other Fortune 25-300 firms operating abroad, not to mention armaments, war materiel, and fuels to Israel, Saudi Arabia, and elsewhere.
Financial profits are again near 50% of total US profits at nearly 8% of private GDP.
The Fed is effectively printing profits to the largest Fed member institutions in exchange for MBS the banks have accumulated with cash from earlier sales to the Fed in lieu of lending because banks’ net margin is negative in real terms after charge-offs and delinquencies as a share of loans.
All of this nonsense about “stimulus” by the Fed is designed to disguise the fact that the banks still have hundreds of billions of dollars, if not trillions, in charge-offs to clear, which is preventing banksters from growing their loan books. “Stimulus” is really “bank liquidation”.
In the meantime, the US gov’t is borrowing and spending $1 trillion a year to prevent nominal GDP from contracting and thus forestall further contraction in bank assets and corporate profits, which are now at a record to GDP, as is non-financial corporate debt to GDP.
Yes, sir, the US gov’t is acting as partner enabler of an imperial monopolistic corporate-state, which the vast majority of us have no ownership stake in because we can’t afford to buy in at avg. revenues of $425,000/employee (per capita).

The case of the UK is very peculiar because the UK over the past 25 years has had extreme bubble conditions.
Because it has been been an oil exporter between 1982 and 2007, it has suffered from the “Dutch disease”, with an overly strong pound, and strong incentives to rent over production.
Because of the goal to shift politics to the right by making most voters petty rentiers, the housing bubble has been far more extreme than that in the USA, and the bust has been very moderate so far; and the housing bubble has been fueled by exporting debt.
Unfortunately now the UK is a net oil importer, with a weak currency, and the very partial housing bust has already caused the nationalization of the losses of most large UK banks.
The UK government is thus desperate to keep nominal interest rates as low as possible, for three reasons:
* If nominal interest rates rise, house prices will collapse, most mortgages will become unrepayable, and this will cause the collapse of all UK banks, something that nearly happened in 2008.
* If nominal interest rates rise, interest payments on the enormous private debt will balloon, and similarly for the fairly large public debt.
* If nominal interest rates rise, the pound will strengthen, causing exports to be even more difficult.
In order to keep nominal interest rates low the UK government has chosen many years of recession as their strategy, because recession keeps down imports of oil and allows nominal interest rates to be low without triggering higher inflation, which is already running fairly high because of the higher cost of imports.
If nominal interest rates go up, and the housing market debubbles causing the collapse of the UK financial systems, the UK will be in an situation similar to Ireland or Lithuania, with a very sharp, long depression, instead of a milder, longer recession.
The only difference between the two political sides in the UK is who is going to pay for this longer recession: conservatives think that the lower paid working classes whether employed or unemployed should pay for it in the form of much lower real wages, to protect the capital gains of rentiers; progressives think that the capital gains of rentiers should be protected too, but the higher paid employees and entrepreneurs should bear more of the cost of the recession than low paid or unemployed workers.
A very Japanese style solution is probably the most likely, and largely for the same reasons.

Menzie, it would sure help if you could define Austerity and how you quantify mild vs severe austerity.
The UK total debt to GDP in their economy is north of 500%. It is the 3rd worst in the world.http://www.gfmag.com/tools/global-database/economic-data/11855-total-debt-to-gdp.html#axzz2JNaTJ8Zp
Do you really think a small (only .5% reduction in Govt spending 2010 to 2011 from Eurostat, 2012 isn’t out yet) Govt cut is the problem? Or is adding more debt to the 500% debt to GDP really the solution? In what universe could you possibly imagine them growing out of this problem?

Anonymous: I’ll rely on IMF WEO data. The IMF has total govt expenditure drop by 1.2 ppts of GDP 2010 to 2011. The structural budget deficit declined by 1.9 ppts of potential GDP over the same time, and projected to decline by another 1.2 ppts 2011 to 2012. It’s fine for you to total public and private debt — what that means is another thing. I look at first when assessing government solvency is net government debt. That is 83.70 ppts of GDP. So…for a country that has been struck by such a large shock, I do believe the UK has been practicing austerity.